(a) Importance of inventory
•• Inventories are important to the financial statements because the inventory figure,
particularly for manufacturing companies, may be material to the balance sheet and
income statement, both in the current year and as a comparative figure.
•• Inventories may be high risk if they are valuable, and/or easily portable. The valuation of
inventories is a matter requiring the exercise of judgment, which means that inventories
are sometimes used to manipulate the appearance of both the income statement and
the balance sheet.
•• In the income statement, there is a direct relationship between the inventory figure and
the profit for the period. If closing inventories are overstated, profits will be overstated.
•• Many key accounting and performance ratios are calculated using the inventory figure.
These include inventory turnover, inventory days, the current ratio and working capital
ratios. Many companies use these ratios for internal purposes and many third parties,
such as investment analysts, also use these figures to assess performance.
•• Poor inventory control will be reflected in inventory figures at the period-end. For many
companies, excess inventory is a sign of serious problems.
•• Some significant cases of litigation against auditors have involved the alleged
overstatement of inventories in financial statements of companies where the auditors
have issued an unqualified audit report before the company has been taken over.
•• There is sometimes relatively little audit evidence for the inventory figure, particularly
for small companies and it is therefore important for auditors to scrutinize the evidence
available carefully and consider the scope for misstatement or deliberate manipulation
of the inventory figure.
(b) Cost and net realizable value
•• IAS 2 requires that cost comprises all costs of purchase, costs of conversion and other
costs incurred in bringing the inventories to their present location and condition.
•• Costs of purchase include the purchase price, import duties and other taxes, transport,
handling and other costs directly attributable to the acquisition of finished goods,
materials and services. Trade discounts, rebates and similar items are deducted.
•• Costs of conversion include costs directly related to units of production such as direct
labour. They also include a systematic allocation of fixed and variable production
overheads that are incurred in converting materials to finished goods.
•• Fixed production overheads are indirect costs of production that remain relatively constant
regardless of the volume of production such as depreciation, the maintenance of factory
buildings and equipment and the cost of factory management and administration. The
allocation of fixed overheads is based on a normal level of production.
•• Variable production overheads vary directly, or nearly directly, with the volume of
production and include indirect materials and labour. The allocation of variable overheads
is based on actual levels of production.
•• Other costs might include the costs of designing products for specific customers and
borrowing costs, which may be included in certain circumstances.
•• Costs not included are storage costs, unless these are necessary to the production
process prior to completion, general administrative overheads and selling costs.
•• Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale, such as advertising costs.
(c) Audit evidence
•• The costs of purchase for a furniture manufacturing company will include purchase
costs such as the cost of timber, metals, fabrics, fillings and adhesives.
•• These costs can be checked on a sample basis from the inventory records through to the daybooks, ledgers and purchase invoices, ensuring that the correct amounts have been recorded in the correct period.
•• The variable production overheads will include direct labour costs (including tax and
social insurance costs), the cost of power for factory machinery, the cost of small tools
and similar items that are directly related to the level of production.
•• Direct labour costs can be checked to payroll records, production records, timesheets
or clock cards, and payment records, including entries in the bank statements. It is likely
that the cost of power for machinery will have to be allocated, but if this is not possible
it may be necessary to include such costs in fixed overheads. In either case, the cost
can be traced to utility invoices and accruals. The costs of small tools can be checked
in the same way as purchase invoices, ensuring that capital items are not included in
the revenue accounts and vice versa.
•• Fixed production overheads will include depreciation of machinery, the cost of heat
and light in the factory, factory administration overheads and storage space for work
in progress. It is important to establish that the factory is operating at a normal level of
activity. If it is not, it is not appropriate to include overheads on the basis of an abnormal
level of activity.
•• Depreciation can be checked to asset registers. It is important that auditors examine
both the accuracy of calculations, and the reasonableness of the depreciation rates
applied as costs may be inappropriately included as assets, otherwise.
•• Factory administration may include the wages and salaries of those administering the
factory payroll for example, and the costs of the offices in which such staff work. It may
be necessary to split such costs out from general administration overheads that should
not be included. The attributable payroll and overhead costs can be checked in the
same way as for direct factory costs.
•• Analytical procedures can also be performed on all of the costs noted above and
compared with prior periods and budgets, as well as production levels, profits and
factory capacity where they vary directly with production or sales.
•• Analytical procedures on gross margins will also provide audit comfort on costs.
•• Cut-off tests may include checks between inventory records, the inventory itself, and
purchase and sales records for a period just before and just after the period-end. It
may also be necessary to examine provisions for goods dispatched or received but not
invoiced before the period-end.
•• The net realizable value of finished goods will only be relevant if it is likely to be lower
than cost, i.e. if furniture is to be sold at a loss. Auditors should review inventory counting
results and inventory records for old or slow-moving inventory and form an opinion, in
discussion with directors, as to whether any such inventories need to be reduced to net
realizable value.
•• Evidence from post year-end sales or contracts is a good source of evidence in relation
to net realisable value. If these are not available, it is important to review the entity’s
previous experience of having to sell furniture below cost. Current market conditions
are relevant as is the existence of a high level of inventories, which may indicate
problems.
Wilfykil answered the question on April 13, 2019 at 07:27
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You have been asked by the manager in charge of the audit of Timab agencies to consider and describe various aspects of carrying out a...
(Solved)
You have been asked by the manager in charge of the audit of Timab agencies to consider
and describe various aspects of carrying out a debtor’s circularization at its year ending 31st
December 2006. The company sells its products on credit and the draft accounts show annual
turnover of twenty five million shillings. The accounts also show debtors of five million shillings.
Your compliance test on the sales system has shown that there is only satisfactory division of
duties in the sales system and only minor errors were found in compliance tests.
Required
a. Consider the reliability of a debtor’s circularization in providing audit evidence and in
verifying value of year end debtors.
b. Describe the work you will carry out in auditing the replies to debtors circularization
where debtor does not reply to circularization
Date posted:
April 13, 2019
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Answers (1)
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Tasty ice cream employs thirty salesmen each with defined geographical area coverage
(Solved)
Tasty ice cream employs thirty salesmen each with defined geographical area coverage. Each
salesperson is supplied with a car which is changed every three years. At end of each week,
each salesperson is submits claim on a preprinted form for expenses with supporting vouchers.
Expenditure is on petrol, repairs and servicing the car, hotels, lunches and entertainment. Each
claim is scrutinized by Beatrice who is the deputy chief accountant. She verifies that the claims
are supported by the vouchers. She clears any inconsistencies with the salesperson concerned
and makes out cheques for signatures by two company directors. The total amount paid in year
ended 31/12/2006 was Kshs. 25,000,000. The company made a profit of Kshs. 125,000,000.
Required:
a. Discuss the short comings of this system and suggest ways of improving the system.
b. List and describe the tests of control the auditor would undertake in this system.
c. During the audit, the auditor discovered that a salesperson in one area was submitting
false claims for entertaining customers. What actions should the auditor take?
Date posted:
April 13, 2019
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Answers (1)
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An extract from the draft audit report produced by an audit junior is given below:
(Solved)
An extract from the draft audit report produced by an audit junior is given below:
Basis of Opinion
‘We conducted our audit in accordance with Auditing Standards. An audit includes examination,
on a test basis, of evidence relevant to the amounts and disclosures in the financial statements.
It also includes an assessment of all the estimates and judgments made by the directors in the
preparation of the financial statements, and of whether the accounting policies are appropriate to
the company’s circumstances, consistently applied and adequately disclosed.
‘We planned and performed our audit so as to obtain as much information and explanation as
possible given the time available for the audit. We confirm that the financial statements are free
from material misstatement, whether caused by fraud or other irregularity or error. The directors
however are wholly responsible for the accuracy of the financial statements and no liability for
errors can be accepted by the auditor. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the company’s annual report.’
Required:
Identify and explain the errors in the above extract.
Date posted:
April 13, 2019
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Answers (1)
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List the audit procedures that should be carried out to determine whether or not the going
concern basis is appropriate for Green Co.
(Solved)
List the audit procedures that should be carried out to determine whether or not the going
concern basis is appropriate for Green Co.
Date posted:
April 13, 2019
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Answers (1)
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Explain the directors’ responsibilities and the auditors’ responsibilities regarding financial
statements prepared on the going concern principle.
(Solved)
Explain the directors’ responsibilities and the auditors’ responsibilities regarding financial
statements prepared on the going concern principle.
Date posted:
April 13, 2019
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Answers (1)
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Walsh Co sells motor vehicle fuel, accessories and spares to retail customers. The company
owns 25 shops.
(Solved)
Walsh Co sells motor vehicle fuel, accessories and spares to retail customers. The company
owns 25 shops. The company has recently implemented a new computerized wages system.
Employees work a standard eight hour day. Hours are recorded using a magnetic card system;
when each employee arrives for work, they hold their card close to the card reader; the reader
recognizes the magnetic information on the card identifying the employee as being ‘at work’.
When the employee leaves work at the end of the day the process is reversed showing that the
employee has left work.
Hours worked are calculated each week by the computer system using the magnetic card
information. Overtime is calculated as any excess over the standard hours worked. Any overtime
over 10% of standard hours is sent on a computer generated report by e-mail to the financial
accountant. If necessary, the accountant overrides overtime payments if the hours worked are
incorrect.
Statutory deductions and net pay are also computer calculated with payments being made directly
into the employee’s bank account. The only other manual check is the financial accountant
authorizing the net pay from Walsh’s bank account, having reviewed the list of wages to be paid.
Required:
a. Using examples from Walsh Co, explain the benefits of using Computer-Assisted Audit
Techniques to help the auditor to obtain sufficient appropriate audit evidence to be able
to draw reasonable conclusions on which to base the audit opinion.
b. List SIX examples of audit tests on Walsh Co’s wages system using audit software.
c. Explain how using test data should help in the audit of Walsh Co’s wages system,
noting any problems with this audit technique.
Date posted:
April 13, 2019
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Answers (1)
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List and briefly explain some of the difficulties of using audit software.
(Solved)
List and briefly explain some of the difficulties of using audit software.
Date posted:
April 13, 2019
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Answers (1)
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Computer-Assisted Audit Techniques (CAATs) are used to assist an auditor in the collection
of audit evidence from computerized systems.
(Solved)
Computer-Assisted Audit Techniques (CAATs) are used to assist an auditor in the collection
of audit evidence from computerized systems.
Required:
List and briefly explain four advantages of CAATs.
Date posted:
April 13, 2019
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Answers (1)
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There are a number of different methods of obtaining audit evidence. Methods include:
(Solved)
There are a number of different methods of obtaining audit evidence. Methods include:
•• Analytical procedures.
•• Audit sampling
•• Tests of controls.
•• Detailed testing of transactions and balances.
•• Computer assisted audit techniques (CAATs)
These methods overlap and may be used for different purposes during an audit of financial statements.
Required:
Describe the relationship between the five methods of evidence gathering described above.
Date posted:
April 12, 2019
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Answers (1)
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(Solved)
Curdco is a company that runs a chain of fast food restaurants. The company has a centralized
operating style and managers of individual restaurants have very limited decision-making powers
on day-to-day operational matters. The company’s centralized administration is responsible for
the buying of food, the payment of staff, the maintenance and cleaning of restaurants by staff
employed by a national agency, and all other matters relating to the running of the business. The
company has good internal controls over purchasing. Inventory counts are conducted at each
restaurant at the year-end. Your firm has recently been appointed as auditor to Curdco.
Required:
a. List the account headings you would expect to find in Curdco’s schedule of accounts payable and accrued expenditure.
b. Describe and give reasons for the audit tests you would carry out to obtain audit evidence for Curdco’s accounts payable and accrued expenditure.
Date posted:
April 12, 2019
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Answers (1)
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Explain the difficulties faced by auditors, and the decisions that auditors have to make, in conducting direct confirmations of accounts payable.
(Solved)
Explain the difficulties faced by auditors, and the decisions that auditors have to make, in conducting direct confirmations of accounts payable.
Date posted:
April 12, 2019
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Answers (1)
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Explain whether the following types of audit evidence meets the standards of relevancy,
reliability and sufficiency as required by the auditor’s operational standards regarding:
• Written confirmation...
(Solved)
Explain whether the following types of audit evidence meets the standards of relevancy,
reliability and sufficiency as required by the auditor’s operational standards regarding:
• Written confirmation of a trade debtor circularized at year end
• Work-in-progress stocks identified during the annual physical stock count
• Solicitor’s letter confirming pending legal action
Date posted:
April 12, 2019
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Answers (1)
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Compare the responsibilities of the directors and auditors regarding the published financial statements
(Solved)
Compare the responsibilities of the directors and auditors regarding the published financial statements
Date posted:
April 12, 2019
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Answers (1)
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The responsibilities of internal and external auditors in relation to the risk of fraud and error differ.
(Solved)
The responsibilities of internal and external auditors in relation to the risk of fraud and error differ.
Explain the responsibilities of external auditors in respect of the risk of fraud and error in an audit
of financial statements
Date posted:
April 12, 2019
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Answers (1)
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Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes commission on holidays sold to customers through its chain of...
(Solved)
Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes commission on holidays sold to customers through its chain of high street shops. Staff are partly paid on a commission basis. Well-established tour operators run the holidays that Stone Holidays sells. The networked reservations system through which holidays are booked and the computerised accounting system are both well-established systems used by many independent travel agencies. Payments by customers, including deposits, are accepted in cash and by debit and credit card. Stone Holidays is legally required to pay an amount of money (based on its total sales for the year) into a central fund maintained to compensate customers if the agency should cease operations.
Describe the nature of the risks to which Stone Holidays is subject arising from fraud and error.
Date posted:
April 12, 2019
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Answers (1)
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Fraud and error present risks to an entity. Both internal and external auditors are required to deal
with risks to the entity.
(Solved)
Fraud and error present risks to an entity. Both internal and external auditors are required to deal
with risks to the entity.
Required:
Explain how the internal audit function helps an entity deal with the risk of fraud and error.
Date posted:
April 12, 2019
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Answers (1)
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You are the audit manager for Parker, a limited liability company which sells books, CDs, DVDs
and similar items via two divisions: mail order and on-line...
(Solved)
You are the audit manager for Parker, a limited liability company which sells books, CDs, DVDs
and similar items via two divisions: mail order and on-line ordering on the Internet. Parker is a
new audit client. You are commencing the planning of the audit for the year-ended 31 May 2005.
An initial meeting with the directors has provided the information below.
The company’s turnover is in excess of Kshs85 million with net profits of Kshs4 million. All profits
are currently earned in the mail order division, although the Internet division is expected to return
a small net profit next year. Turnover is growing at the rate of 20% p.a. Net profit has remained
almost the same for the last four years. In the next year, the directors plan to expand the range of
goods sold through the Internet division to include toys, garden furniture and fashion clothes. The
directors believe that when one product has been sold on the Internet, then any other product
can be as well.
The accounting system to record sales by the mail order division is relatively old. It relies on
extensive manual input to transfer orders received in the post onto Parker’s computer systems.
Recently errors have been known to occur, in the input of orders, and in the invoicing of goods
following dispatch. The directors maintain that the accounting system produces materially
correct figures and they cannot waste time in identifying relatively minor errors. The company
accountant, who is not qualified and was appointed because he is a personal friend of the
directors, agrees with this view, The directors estimate that their expansion plans will require a
bank loan of approximately Kshs30 million, partly to finance the enhanced web site but also to
provide working capital to increase inventory levels. A meeting with the bank has been scheduled
for three months after the year end. The directors expect an unmodified auditor’s report to be
signed prior to this time.
Required:
Identify and describe the matters that give rise to audit risks associated with Parker .
Date posted:
April 12, 2019
.
Answers (1)
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Ajio is a charity whose constitution requires that it raises funds for educational projects. These
projects seek to educate children and support teachers in certain countries
(Solved)
Ajio is a charity whose constitution requires that it raises funds for educational projects. These
projects seek to educate children and support teachers in certain countries. Charities in the
country from which Ajio operates have recently become subject to new audit and accounting
regulations. Charity income consists of cash collections at fund raising events, telephone
appeals, and bequests (money left to the charity by deceased persons). The charity is small
and the trustees do not consider that the charity can afford to employ a qualified accountant.
The charity employs a part-time bookkeeper and relies on volunteers for fund raising. Your firm
has been appointed as accountants and auditors to this charity because of the new regulations.
Accounts have been prepared (but not audited) in the past by a volunteer who is a recently
retired Chartered Certified Accountant.
Required:
Describe the risks associated with the audit of Ajio under the headings inherent risk, control risk and detection risk and explain the implications of these risks for overall audit risk
Date posted:
April 12, 2019
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Answers (1)
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List and explain the audit tests to be performed on income and expenditure from fund raising events.
(Solved)
List and explain the audit tests to be performed on income and expenditure from fund raising events.
Date posted:
April 12, 2019
.
Answers (1)
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Rhapsody Co supplies a wide range of garden and agricultural products to trade and domestic
customers. The company has 11 divisions, with each division specializing in...
(Solved)
Rhapsody Co supplies a wide range of garden and agricultural products to trade and domestic
customers. The company has 11 divisions, with each division specializing in the sale of specific
products, for example, seeds, garden furniture, and agricultural fertilizers. The company has an
internal audit department which provides audit reports to the audit committee on each division
on a rotational basis.
Products in the seed division are offered for sale to domestic customers via an Internet site.
Customers review the product list on the Internet and place orders for packets of seeds using
specific product codes, along with their credit card details, onto Rhapsody Co’s secure server.
Order quantities are normally between one and three packets for each type of seed. Order details
are transferred manually onto the company’s internal inventory control and sales system, and
a two part packing list is printed in the seed warehouse. Each order and packing list is given a
random alphabetical code based on the name of the employee inputting the order, the date, and
the products being ordered.
In the seed warehouse, the packets of seeds for each order are taken from specific bins and
dispatched to the customer with one copy of the packing list. The second copy of the packing list
is sent to the accounts department where the inventory and sales computer is updated to show
that the order has been dispatched. The customer’s credit card is then charged by the inventory
control and sales computer. Bad debts in Rhapsody are currently 3% of total sales.
Finally, the computer system checks that for each charge made to a customer’s credit card
account, the order details are on file to prove that the charge was made correctly. The order file
is marked as completed confirming that the order has been dispatched and payment obtained.
Required:
a) In respect of sales in the seeds division of Rhapsody Co, prepare a report to be sent to the
audit committee of Rhapsody Co which:
i. Identifies and explains four weaknesses in that sales system.
ii. Explains the possible effect of each weakness.
iii. Provides a recommendation to alleviate each weakness.
Date posted:
April 12, 2019
.
Answers (1)